Saving Money and Reducing Debt

Learning A Little Bit About Dividends

I was recently looking through the list of investing blogs over at pfblogs.org and I clicked on The Dividend Guy Blog. I was very interested in what I found, and I contacted “the dividend guy” – and asked him if he would write a guest post for No Credit Needed. While I know a good bit about debt reduction and saving money, I am brand-new to investing. I wanted a post that would describe dividends, what they are, and why they matter. I want to thank The Dividend Guy Blog for the following informative guest post and I encourage you to check out his site. As always, information provided here at No Credit Needed is for entertainment purposes only and you should not consider the following to be financial advice, professional or otherwise. Do your own research and consult a financial professional before making any investment choices.

Dividend Investing 101

This article will provide some of the basics of dividend investing.

What is a Dividend and the Dividend Yield?

In the stock market, money can be made in one of three ways:

1. Share price growth – you buy shares in a company at one price and then sell it at a later date for a higher price (hopefully).
2. Interest on bonds or other fixed income assets – you can collect interest from a bond that is essentially you lending money to a bank or company. Interest payments are typically guaranteed payments you can receive on your invested money for a set period of time. At the end of that fixed time, you get all your principle back.
3. Dividends – the topic of today’s discussion!

The technical definition of a dividend is a distribution or payment in the form of cash on some portion of a company’s earnings to the shareholders.

In more simple terms, a dividend is money a company gives you for each share of stock you own in that company. It is cash the company pays you for being a shareholder.

Dividends are often quoted as either the dividend per share (DPS) or dividend yield. The DPS is simply the dollar amount, per share of stock that you hold, that will be paid to you depending on the number of shares you hold. For example, if you own 100 shares of Coca-Cola and the dividend is $1.36 per share, you as an investor can expect to receive dividend payments from the company of $136 per year (note: when you read a stock quote and look at the dividend section, the amount quoted is the yearly amount in dividends the company pays per share, unless otherwise noted).

The more common way dividends are quoted is through the dividend yield of the company. The dividend yield shows how much a company pays out in dividends as a percentage of its share price. The formula to calculate the dividend yield is not complicated. You can do it yourself, however most investor websites where you get your stock quotes will have dividend yield calculated for you:

Dividend Yield = Annual Dividends Per Share (DPS) / Price Per Share

The way I look at dividend yield, is that is is the return on investment an investor will receive from a stock if they buy it at a particular price. Lets look at an example using our Coca-Cola example:

Share Price: $56.40

DPS: $1.36

Dividend Yield: 2.4% ($56.40 / $1.36)

If an investor bought Coca-Cola at this price and this DPS, then every year they hold the stock they will see a return on their investment of 2.4% from the dividends alone.

Compounding: Putting Your Dividends to Work

Now that we have a good understanding of what dividends are and how to calculate the dividend yield, we need to talk about what an investor can do with the dividend payments they receive. There are two choices:

1. Take the dividends out of your brokerage account and spend them on what ever you want
2. Use the dividends to buy more shares of a company

The first choice is not ideal if you are trying to build up your investment portfolio. It may be for you if you are living off your dividend income, but for the purposes of this article we will assume that you are at the asset accumulation phase in your investing career and trying to grow your portfolio.

The second choice is called compounding – income from dividends is reinvested into more assets that provide more income. Each time an investor receives a dividend payment from a company, that income is reinvested into more shares of that company or another company. As this continue to happen year after year, you will find that the dividend income you receive from your portfolio will increase allowing you to reinvest it into more and more assets. It is a wonderful circle of cause and effect. To highlight the power of compounding, I will once again go back to our Coca-Cola example. Let us assume that you as an investor bought $10,000 worth of Coca-Cola stock and you reinvested all the dividends you received back into more shares of Coca-Cola. Here is what your investment would look like in 20 years,

This chart does not even take into account the change in share price that Coca-Cola would see over that time period. The key thing to note is that if Coca-Cola’s share price stayed exactly the same as the day you bought the stock and you reinvested the dividends into more Coca-Cola stock, your $10,000 would grow to $16,069 in 20 years based on the dividends alone. We all know that stocks also see their share prices grow so in 20 years, an investor would expect to see the gain from an increased share price as well.

Looking for Dividend Growth

One last thing I would like to cover before we finish here is an important consideration for dividend investors. It is the first thing that I look for when deciding to buy a stock or not. It is called dividend growth – when a company raises the dividend per share paid to investors on an annual basis. This is an important factor because if actually provides more power to the compounding machine we spoke about above. Going back to the compounding example above, if Coca-Cola increases its dividend per share ever year, then ever year you are receiving more dividends. This provides you with more income to buy more shares. It happens over and over again and will further compound your returns in that investment.

Where to Find Potential Dividend Investments that Increase Their Dividends

There are two potential sources of dividend growth stock ideas that an investor can look at to generate ideas for further research. They are called the Dividend Achievers and the Dividend Aristocrats.

Dividend Achievers: Stocks that have increased their dividends for at least 10 years

Dividend Aristocrats: Stocks that have increased their dividends for at least 25 years
These lists are not meant to be buying recommendations. I use this list to look for companies that I want to invest in, and then do further research on them by looking at such things as earnings, revenue, and cash flow. Only then do I buy shares in that company.

The Dividend Guy runs an investment blog focused on investing in high dividend stocks and dividend growth stocks. His vision for the site is to share his passion for investing in high dividend stocks that consistently grow their dividends to ensure a steady stream of dividend cash flow building up to his retirement.

Great post. What most folks don’t realize is dividends have made up 1/3 of the stock market’s return over the past 75 years.

Both the Aristocrats and Achievers can be bought in an ETF for those of you who would rather own a more diversified fund than picking individual stocks. The Achievers ETF is operated by Powershares (ticker: PFM) while the Aristocrats is run by Streetracks (SDY).

Thanks so much for this post. It was really informative. It’s nice to have an occasional baby bite of investing knowledge. It’s overwhelming enough sometimes just getting on top of our budget & savings. Investing sites are still too intimidating. So, a teaspoon is just the right amount.